USD Outlook Hinges On FOMC, Euro At Risk Amid Growing Opposition

Market sentiment firmed up ahead of the FOMC interest rate decision amid hopes that Chairman Ben Bernanke will show a greater willingness to conduct another round of quantitative easing, but we may see the committee move away from the non-standard measure as the world’s largest economy gets on a more sustainable path.

Talking Points

• U.S. Dollar: Index Continues To Hold 10,000 – All Eyes On FOMC
• Euro: Bundesbank Warns On ECB Mandate, RSI Threatens 2012 Trend

U.S. Dollar: Index Continues To Hold 10,000 – All Eyes On FOMC

The greenback was little changed on Wednesday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) trading within the previous day’s range, but we may see the reserve currency track higher during the North American trade should the Federal Reserve talk down speculation for QE3. Indeed, the FOMC is expected to maintain its current policy as the committee continues to carry out ‘Operation Twist,’ and we may see Fed Chairman Ben Bernanke continue to soften his dovish tone for monetary policy as growth and inflation picks up. In turn, the central bank head may endorse a wait-and-see approach over the remainder of the year, and the committee may start to discuss a tentative exit strategy as the recovery gradually gathers pace. As the USDOLLAR continues to hold above the 10,000 figure, a less-dovish Fed should help the greenback to retrace the sharp decline from the previous month, but we may see the index fail to maintain the upward trend from earlier this year should the central bank show an increased willingness to push through another large-scale asset purchase program.

Euro: Bundesbank Warns On ECB Mandate, RSI Threatens 2012 Trend

The Euro is struggling to hold its ground ahead of the European Central Bank interest rate decision as Bundesbank President Jens Weidmann argues that the Governing Council should ‘not overstep its own mandate,’ and the policy meeting on tap for Thursday may fail to shore up the single currency should we see a growing rift within the central bank. Although the ECB is widely expected to keep the benchmark interest rate at 0.75% in August, there’s speculation that President Mario Draghi will move to expand the balance sheet further, but the central bank head may struggle to sway the committee as the governments operating under the monetary union become increasingly reliant on monetary support.

At the same time, German officials continued to voice their opposition to provide the European Stability Mechanism with a banking license, and the ECB may have little choice but to embark on its easing cycle throughout the remainder of the year as the EU maintains a reactionary approach in addressing the debt crisis. Despite the range-bound price action in the EURUSD, we’re keeping a close eye on the relative strength index as it threatens the downward trend from earlier this year, and a breach above the 50 figure would encourage us to scale back our bearish forecast for the euro-dollar as the pair appears to be finding interim support around the 10-Day SMA (1.2222).

— Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

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